大浩浩的笔记课堂——FRM考试学习笔记099

Topic 28 Netting,Compression,Resets,and Termination Features

1.Netting:

⑴netting mechanisms:

①payment netting 付款净值结算：

A.definition:

Combining the cash flows from different contracts with a counterparty into a single net amount,net cash flows occurring on the same day.

其是指交易双方同时结算互偿款项时，只需由一方向另一方支付付款净值的过程。

B.hedging risks:

settlement risk,operational risk

C.characteristics:

a/ It allows an institution to combine same-day cash flows into a single net payment.This reduces settlement risk and enhances operational efficiency.

b/ However,it does leave operational risk,which has been illustrated in a recent high-profile case during the financial crisis.

②closeout netting 清盘净值结算：

A.definition:

It allows the termination of all contracts between the insolvent and a solvent counterparty,together with the offsetting of all transaction values.The netting of contract values with a counterparty in the event of the counterparty´s default.

其是指在交易终结之时所实施的净值结算，此时只发生净轧差金额的债务关系。

B.hedging risks:

counterparty risk(pre-settlement risk)

C.usage:

The 3 categories of the trades need for closeout netting:

a/ trades may constitute hedges

b/ trades may constitute unwinds in that,rather than canceling a transaction,the reverse trade may have been executed

c/ trades may be largely independent

D.characteristics:

a/ close out:

the right to terminate transactions with the defaulted counterparty and cease any contractual payment

b/ netting:

the right to offset amounts due at termination of individual contracts to determine a net balance

c/ reducing risk:

Closeout netting is relevant to counterparty risk since it reduces pre-settlement risk,netting agreements are crucial.

⑵netting arrangements:

①They would involve multiple counterparties to mitigate counterparty and operational risk.

②Typically,multilateral netting is achieved with a central entity,such as an exchange or clearinghouse.

③The futures would have the most beneficial effect on netting.

⑶netting sets and subadditivity:

①Across netting sets,exposure will always be additive,whereas within a netting set market-to-market values can be added:

So,a trading instrument will have a beneficial effect on netting if it can have a negative market-to-market value during its life.(e.g.future)

②Within a netting set,quantities,such as expected exposure and CVA are non-additive.

⑷the impact of netting:

①Netting means that the overall credit exposure in the market grows at a lower rate than the notional growth of the market if self.

②Netted positions are inherently more volatile than their underlying gross positions,which can create systematic risk.

⑸product coverage:

Cross-product netting is typically possible within one of these categories(interest rate and foreign exchange transactions),netting across these product categories(OTC and repos) is usually not possible.

2.Termination features and trade compression:

⑴reset agreement:

①It avoid a trade becoming strongly in-the-money by means of readjusting product-specific parameters that reset the trade to be more at-the-money.

②The reset means that the notional on one leg of the swap will change,such a reset is similar to the impact of closing out the transaction and executing a replacement transaction at market rates and consequently reduces the exposure.

⑵additional termination events(break clauses):

①the usage of termination events:

They are useful in giving the possibility for an institution to terminate a trade prior to their counterparty´s creditworthiness deteriorating to the point of bankruptcy.

②The events can be defined to fall into 3 categories:

A.mandatory:

The transaction will definitely terminate at the date of the break clauses.

B.optional("gimmicks""moral hazard""exercise early before"):

They have the option to terminate the transaction at the pre-specified date.

C.trigger-based:

A trigger(typically a ratings downgrade) must occur before the break clauses may be exercised.("banker´s paradox")

·特别注意！

·Using credit ratings,create further problems:

*Rating transactions probabilities can not be implied from market data.

*Ratings have been shown to be extremely slow in reacting to negative credit information.

·特别注意！

·reset agreement vs. break clauses:

⑶walkaway features(tear up,1992年以前popular):

①It effectively allows an institution to cancel transactions in the event that their counterparty defaults.They would clearly only choose to do this in case they were in debt to the counterparty.

②Even without an explicit walkaway agreement,an institution can still attempt to gain in the event of counterparty default by not closing out contracts that are out-of-the money to them but ceasing underlying payments.

③Any type of walkaway feature is arguably rather unpleasant and should be avoided due to the additional costs for the counterparty in default and the creation of moral hazard.

⑷trade compression:

①It reduces net exposure without the need to change the overall risk profile.

②It is an approach for utilizing multilateral netting without the need for a membership organization.

③Compression aims to reduce the gross notional amount and the number of trades(e.g.,OTC derivatives transactions)

④Exchange or central counterparty via trade compression can reduce the operational costs,but also can minimize counterparty risk.

⑸multilateral netting:

①advantage:

Even non-matching exposures could be reduced to their lowest level.

②disadvantages:

A.However,implementation of multilateral netting is not trivial.

B.It tends to mutualise and homogenize counterparty risk,reducing incentives for institutions to scrutinize the credit quality of their counterparties.

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